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Fool on Call: Abercrombie, Rebel No More?

Bland products and tight control over merchandise may be hurting sales.

By now, Fools have had a chance to digest the latest numbers from youth-apparel retailer Abercrombie & Fitch (NYSE:ANF). Its negative comparable-store sales in the most recent quarter led my colleague Timothy Otte to conclude that the company may be missing the next fashion wave among its young customers.

As a frequent shopper at youth apparel retailers -- yes, I'm just barely young enough to qualify -- I don't think Abercrombie's missed any such trend. Instead, I think the company's stuck in a sea of bland conformity. The former iconic brand, which once rebelled from the clean-cut khaki legions of Gap (NYSE:GPS), is now part of the status quo.

In this edition of "Fool on Call," we'll discover management's opinion on its brand identification, and examine how A&F's organizational structure may be restricting diversification between brands.

Abercopy and Filch?It's bad enough that both Aeropostale (NYSE:ARO) and American Eagle Outfitters (NYSE:AEO) bear striking resemblance to A&F's attire. Even more alarmingly, A&F's own primary brands -- Abercrombie & Fitch, RUEHL, and Hollister -- do little to distinguish themselves one from the other. Look at the plaid shorts from Hollister, and then from Abercrombie -- is there really much difference between them, save Hollister's lower price? I find the same similarity among A&F's jeans, button-up shirts, and polo shirts, too.

Even the high-end RUEHL fails to distinguish itself. If the RUEHL stores I've visited offer anything different from their less expensive siblings, I have yet to find it. I'm not surprised that RUEHL isn't yet profitable, if shoppers such as I can't see the logic in paying up for a product that's nearly identical to its cheaper brand brothers.

Built for blandness? CEO Mike Jeffries began the call by pointing to the apparent culprit behind Abercrombie's too-similar brands:

In contrast to other companies that are hindered by a rigid structure of divisions, which can result in a lack of information flow, creating counterproductive competition within business units, at Abercrombie & Fitch, our brands are aligned to benefit from sharing resources and data. For example, we consolidate selling data to help make more informed merchandise planning decisions. This ultimately leads to a strong gross margin.

True, saving time and money by plugging the various brands into the same merchandise data can lead to stronger gross margins. But the same structure could also lead to uniformity among the brands, ultimately hampering sales results. And if the top line begins to suffer, the retailer might be forced to sell more items at a discount to clean out inventory, weakening those same gross margins.

Management and micromanagementTo Abercrombie's credit, the company is a masterful inventory manager. Despite weak comps results this quarter, the company actually improved gross margins, albeit by a slim 0.2%. One analyst raised this point during the Q&A session of the call, to which Jeffries responded, "We do a very job balancing inventories with demand." He added, "We are quite proficient at inventory management, and we are paranoid about it." A well-managed inventory system is great, but how much more impressive would results be if comps were actually positive?

Again, I believe that the weaker comps stemmed partly from A&F's indistinguishable offerings among its varying brands. Management clearly disagrees ... or do they? When an analyst asked about the strength of each brand, Jeffries said, "I think that the brands look distinctive." But moments later, he added: "There aren't wide fluctuations by brand, by category. ... This is becoming a very, very consistent business through intense control." Which is it?

I think Abercrombie's exerting too much control over its brands, micromanaging all the originality out of them. The fashion biz is tough, as abundant copycats make it difficult to distinguish one's brand from the competition. But Abercrombie's now facing an even more pronounced problem: distinguishing itself from ... itself. Yikes!

Is Abercrombie doomed?Abercrombie may be going through a tough patch, but there's still a lot to like here. We learned in the call that the retailer has its sights set on international expansion, both in Europe (starting with a flagship store in London) and eastern Asia (with a flagship operation in Tokyo). Despite my disappointment with its apparel, RUEHL should actually turn profitable by year's end. And, in perhaps the call's biggest news, Abercrombie will launch an entirely new brand with seven stores early next year. No further details were provided on this important development.

The call also reminded investors of Abercrombie's powerful ability to quickly and efficiently manage inventories. Without such effective information flow in its inventory system, the company's earnings this past quarter would have fared much worse. However, prospective investors should know that this same information flow may lead to Abercrombie's Achilles heel: bland, identical merchandise. To keep producing stylish results for shareholders, Abercrombie's management must balance its smoothly running, profit-producing inventory system with greater diversity and freedom of design among its core brands.